Wednesday, December 9, 2015

Current Market - Bear Case Evaluation

Over the past few weeks we have seen a stagnant market. In fact, entire 2015 was a sideways market with SP500 starting the year around 2080 and is now at 2060. Although sideways action is good to digest gains, this kind of action can also be attributed to distribution. Distribution means shares are being sold by strong hands to weak hands. Distribution typically takes place near the top and results in market declines.

From a psychological perspective it makes sense because when the people how bought at lower levels sell and people who buy at higher levels are left in the market it has two consequences:
  1. Weaker buyers are the first to sell, which exaggerates selling
  2. When all the buyers have bought, sellers are left in the market. Since weak hands join the rally towards the end, the concentration of sellers is very high near the top
At the same time, the weaker buying hands are being sold-to by strong shorts. That's why this process is known as distribution. Now there can be this argument, as stated above, that we are tracing out a longer-term consolidation pattern before a very nice rally. Although this is possible, it is unlikely due to the following facts:
  1. Average gap between recessions in the US, over the past century, is ~5 years. Since last recession ended 6 years ago, we are due for another recession
  2. Markets rally in easy monetary policy environment. Under current circumstances, Federal Reserves is planning to raise the interest rates, which will reduce the monetary supply that fuels bull markets
  3. Stocks PE valuation is also at a very high level, which is another reason not to be very aggressive with the stocks
Above reasons suggest that from a fundamental perspective stocks are not the most attractive investment opportunity at this time.

Our proprietary model suggests that the stocks entered a bear market in August and recent rally hasn't been able to change that status. Market will remain in the bear market mode till we see a broader rally. However, so far we haven't seen the kind of broader rally that is a hall-mark of a new bull phase.

Therefore, we will continue to evaluate the market conditions and also review other alternative investments at a time when the stocks don't seem to be the best option. In the next few posts we will  cover:
  • Technical overview of the stock market
  • Importance of objectivity and trend following
  • Alternative investments
  • Asset allocation
  • Tax implications


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